The credit crisis sparked by mortgage problems reared its head anew, as stocks tumbled on fears about shaky financial institutions. This time, the dollar's fall to record lows and oil's flirtation with $100 a barrel added to the worrisome brew.
The Dow Jones Industrial Average fell 360.92 points, or 2.64%, to 13300.02. The index has now wiped out all of its gains since the Federal Reserve on Sept. 18 made the first of its two recent interest-rate cuts, sparking a short-lived rally that sent the Dow to a record high Oct. 9.
Wall Street is once again nervous about how much damage remains from subprime mortgages and other bad credit, even after tens of billions of dollars in write-downs. The wave of credit-rating downgrades on mortgage securities continued yesterday, and bank shares were especially hard-hit. Shares of Washington Mutual Inc., a major lender, lost 17%, and after the market closed American International Group Inc. and Morgan Stanley reported new write-downs connected to housing problems. (See related article.)
Something else is beginning to nag at investors. The dollar and oil are pushing to opposite extremes, one to record lows and the other near record highs. Gold, an age-old refuge in times of financial turmoil, is once again above $800 an ounce. The combination of economic worries and market movements is reminiscent of the chaotic 1970s, when the U.S. was beset by inflation, recession and a stock market going nowhere.
The global economy is much different today than it was then. Inflation is generally under control, and most investors trust central banks to keep it that way. The U.S. economy, though slowing, has kept growing even as higher energy prices hit consumers.
Still, the parallel points to some challenges that policy makers are trying hard to manage. One is the threat of inflation. Another is the risk of a broad international loss of confidence in America and its currency, which has long been the place where countries with big foreign reserves put the bulk of their assets.
"This is a critical juncture," said Jim O'Neill, head of global economic research at Goldman Sachs. "The dollar is behaving in the past couple of days as though the market is testing its reserve-currency status."
On Wednesday, the dollar took a sharp turn lower against several major currencies, sliding to a new record low against the euro and hitting its lowest level in decades versus the Canadian dollar. One dollar now buys only about 93 Canadian cents. At one point in 2000, the euro was worth only 85 cents. Now one euro buys $1.46.
One spark behind the dollar's latest downturn was a comment by a Chinese lawmaker suggesting that the country should buy more euros. Although the lawmaker isn't responsible for financial policy and later amended the remark, the comment fueled pessimism about the dollar's prospects amid slowing U.S. economic growth.
The price of oil, meanwhile, is pushing toward $100 a barrel, a price that just a few years ago most economists agreed could fuel a nasty recession. Strong demand from developing countries, constrained supplies around the world and speculative pressure are joining to push it higher. And gold closed yesterday at $831 an ounce on the New York Mercantile Exchange, its highest level since 1980, as investors sought its perceived protection against inflation.
The combination of movements in the dollar, oil and gold was similar in the 1970s. Back then, the dollar became unhinged after President Nixon abandoned the gold standard and the global system for regulating exchange rates collapsed with it. That was one factor behind oil's rise during that decade. Because oil is traded in dollars, exporters were earning less in other currencies for every barrel, and had a big incentive to restrict supply to drive up prices.
The world is far different today. The 1970s were wracked by recession and double-digit inflation. Today, strong global growth is a major force pushing the price of oil and the dollar in opposite directions. Central banks are acutely aware of the danger posed by inflation, and declare their readiness to move quickly to combat it. U.S. consumer prices in October were up 2.8% from a year earlier.
"Economies are much more resilient and much less prone to a creeping inflation process," says Eric Chaney, an economist at Morgan Stanley in London.
Fears of a falling currency were likely a factor when the Fed signaled last week, at the time of its latest interest-rate cut, a reluctance to cut rates again. The dollar's decline "could lead to higher prices for imported goods," Fed governor Kevin Warsh said yesterday. "If these same forces cause inflation expectations to become less reliably anchored, then inflation could increase in the longer run as well."
So far, the dollar's decline has benefited U.S. exporters by making their goods cheaper abroad and boosting the value in dollars of money earned overseas. That has helped lift the share prices of many multinationals. Taken too far, however, a dollar slide could hurt stocks broadly, if investors become unwilling to hold U.S. dollar assets.
"If you get a dollar rout and people start dumping quickly, that will complicate monetary policy and undermine the Goldilocks scenario that investors are hanging on to," said Russ Koesterich, head of investment strategy at Barclays Global Investors.
George Magnus, a senior economic adviser at UBS AG, notes some echoes of the past in the way some international investors are treating the dollar. Back in the 1970s, Germany and Japan, which had supported the dollar, tried to demand gold in exchange for their burgeoning reserves.
Today it's oil-producing countries and emerging economies like China that find themselves sitting on mountains of dollar reserves that are losing value. Some are looking to diversify their reserves, for instance by creating sovereign wealth funds that turn those dollars into other real assets. China has purchased a stake in Blackstone Group, the private-equity firm. "Some of the storylines are the same but the characters are obviously different," says Mr. Magnus.
As before, a sliding dollar gives oil exporters an incentive to keep prices high to avoid eroding their own purchasing power, although the major causes of high oil prices are soaring demand and constrained supply as key producer nations are unable to raise output.
The dollar's swoon means that consumers in different parts of the world don't feel the same pain. Since the start of 2003, oil prices in dollars have tripled, but in euro terms, they have a little more than doubled.
Some economists fret about a vicious cycle in which Persian Gulf countries put more of their oil earnings into the euro and other currencies, which drives down the dollar and leads the oil producers to keep a tighter leash on production. That drives up oil prices and brings in even more money for the countries to convert into nondollar currencies.
Some analysts say oil markets have attracted investors specifically looking for a hedge against the rapidly falling dollar. "The perception is that you want to own whatever benefits from the dollar weakening. And commodities are an ideal play on that," says Ben Dell, an energy analyst at Sanford C. Bernstein & Co.
John Taylor, head of FX Concepts, a New York-based hedge fund that specializes in currency trading, was a foreign-exchange analyst in 1970s. Then, he says, the U.S. was also struggling with budget deficits due to war spending and with a spike in commodity prices. One advantage the dollar enjoyed in the 1970s was that the U.S. still saved more than it spent. Now the country depends on foreign money to finance its debt, which could keep the dollar under pressure.
But Mr. Taylor is also more optimistic about the ability of leading governments to coordinate action to stop the dollar's slide if needed. The Group of Seven developed nations, which had its first meetings in the 1970s, has built three decades of experience responding to currency gyrations.
By JOANNA SLATER and CRAIG KARMIN
November 8, 2007; Page A1
